Lack of income, savings, and wealth are the three strikes of financial inequality. The economic upheaval of 2020 wasn’t an overnight phenomenon: Returns from equity markets have been strong, but median income has stagnated over the past 30 years. Only a small percentage of the global population owns equities or has any exposure to the capital markets.
For many, the surge in unemployment from Covid-19 was just the tipping point. While it is clear that without adequate income you can’t even begin to build wealth, income inequality, as a concept, masks a larger problem. In most cases, disparities in wealth are even more severe. Recent research shows that as recently as 2016, the net worth of a typical white family in the U.S. was nearly 10 times greater than that of a Black family. Similar gaps exist even for families with the same income. These wealth disparities drive economic instability.
For households, the core function of capital markets is to turn savings derived from income into wealth, usually over long time horizons. Why, then, are the markets not accomplishing this goal? One key reason is that the extended investment horizons that households need to build financial security, often a decade or more, are much longer than those of the markets in which they entrust their savings. Savers are exposed to unnecessary risk when the gap in horizons extends too far, with asset managers aiming for goals far shorter than those of their clients. For savings to turn into real financial security, a realignment is required.
Data from our new project, FCLTCompass, show the severity of the mismatch. As recently as 2018, household savers said they intended to invest for just over 13 years, when in fact they actually invest for five years; this gap has hovered between eight to nine years for a decade. Capital markets as currently structured aren’t meeting savers’ long-term intentions. The scarcity of long-term-oriented asset classes prompts institutional investors to prioritize near-term gains, and in some cases leads savers to hoard cash, both of which stifle growth and returns.
Like savers, companies also generally have long-term investment intentions, allocating capital in support of their strategy. But there is an “intention allocation” gap here, too, with a disconnect between a company’s use of capital and its much shorter-horizon sources of funding. We found that public companies allocated capital on a blended average basis of five years, seven months in 2018—down from six years, six months in 2009. But taken as a whole, the dollar-weighted average investment horizon of typical asset classes—cash, real estate, or equity, for example—is just five years.
In a well-functioning market, asset owners and managers invest to meet the long-term goals of their beneficiaries, clients, pensioners, and so on—the average household saver—and companies take that money to drive innovation, create jobs, and fuel economic growth. This self-reinforcing cycle is how strong capital markets support a thriving economy over the long term. But all of these market participants can struggle to balance immediate financial needs or pressures against long-term objectives.
Though the intention-allocation gaps are shrinking, they are still significant enough to put undue pressure on companies to shorten their own investment horizons. Improved synchronicity would unlock the full potential of capital markets for savers, investors, and companies alike.
To begin to close the wealth gap, we need to shrink the investment-horizons gap. There are practical steps that companies, investors, and savers themselves can take.
Companies should pursue long-term goals and build toward them through their day-to-day activities. This can include increasing investments in innovation, judiciously returning capital to shareholders, or re-evaluating pay structures to align with long-term performance.
Investors need to focus on meeting the future needs of their stakeholders, made possible by incorporating into in their strategy long-term trends or disruptive risks, such as changing demographics, climate change, the move to algorithmic investing, or technological change. Restructuring asset-manager incentives in a way that emphasizes long-term gains over short-term targets is a good step forward in this regard.
Individuals need far greater access to, participation in, and knowledge of capital markets than we see today. Retirement plans with default settings to start saving sooner lead to both greater savings and greater wealth accumulation over time. Time is on the savers’ side, and long-term retirement-savings plans give employees greater access to longer-term asset classes that individuals normally couldn’t invest in, such as private equity or infrastructure. Greater financial inclusion will also lead young people to better understand the financial choices they’ll make later in life and highlight the benefits of financial literacy.
Many things must happen to recover from the downturn of 2020. Understanding and closing the intention-allocation gap is just one of them, but one that the investment industry can embrace.
Sarah Keohane Williamson is CEO of FCLTGlobal, a nonprofit that develops research and tools to encourage long-term business and investing.
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